Who let the funds out? The impact of institutional ownership on short-term volatility of share prices

Abstract

We find evidence that higher aggregate institutional ownership is associated with increased volatility during market price swing days. Mutual funds having the largest impact on this positive relationship (demanding for liquidity), while hedge funds act as contrarian traders during the up market, providing liquidity. We also find evidence that hedge funds were able to provide liquidity during the Financial crisis. Further analysis of crisis periods shows that banks abandoned their contrarian trading strategies in the Financial Crisis, asking for liquidity instead, and insurance companies demanded liquidity during the COVID-19 crash, during days when the market was down. For pension funds no significant impact on abnormal returns during swing days could be determined.

We use Fama-MacBeth regressions on firm-level abnormal returns to examine the impact of firm ownership structure on short-term volatility, analyzing over one million observations from the investable U.S. equity market between 1988 and 2023 on market price swing days (days when the market portfolio's absolute returns exceeded 2%). We employed regressions on both the whole sample and through different crisis and non-crisis periods. The regressions were conducted on both the aggregate institutional ownership variable, and on individual institutional ownership types (mutual funds, hedge funds, banks, insurance companies and pension funds).